CANADA ON THE ROPE$
Mansharamani, PhD, is a lecturer in the Program on Ethics, Politics,
& Economics at Yale University and a senior fellow at the
Mossavar-Rahmani Center for Business and Government at the Harvard
years, the global community praised Canadian financial conservatism
and the country’s success in skirting the global financial
crisis. Canadian banks were seen as among the world’s
finest, appropriately capitalized, and well-run. They still
are. Globalization and interdependency, however, are perniciously
eating away at the fortress of stability that Canada once was.
country is today one of the world’s most vulnerable large
economies, and there are three key reasons for this precarious
position: First, Canadian household debt levels are extremely
high by almost any measure. Second, housing prices are elevated
and continue to rise, driven by both confident Canadians and
foreigners. More debt accompanies these higher prices, further
escalating the vulnerability. Lastly, the proverbial straw that
may break the Canadian camel’s back is the recent collapse
of crude oil prices. Lower crude oil prices are rippling through
the energy-exporting economy and will adversely affect employment,
the federal budget, consumer confidence and ultimately real
estate. The virtuous cycle appears poised to turn vicious.
begin by looking at Canadian household debt. According to the
McKinsey Global Institute’s February 2015 report “Debt
and (Not Much) Deleveraging,” Canada’s household
debt-to-income ratio grew by a staggering 22 percentage points
between 2007 and mid-2014, matching household credit growth
in China and lagging that of Greece (30 percent). Meanwhile,
US household credit actually shrank by 26 percent as risk aversion
led to rapid deleveraging.
household debt, C$1.82 trillion, now exceeds GDP, C$1.6 trillion,
approximately C$1.3 trillion of which was for residential mortgages.
Further, household debt is now more than 160 percent of disposable
income – meaning it would take about 20 months for a family
to pay off its debt if interest rates were 0 percent and they
spent their entire disposable income to do so. The Bank of Canada
highlighted “elevated levels” of household indebtedness
as one of the key vulnerabilities of the Canadian economy.
then there’s the Canadian shadow-banking sector that is
booming. As a result of regulatory efforts to contain the housing
froth, mortgages insured by the Canadian government are no longer
growing. Uninsured private mortgages are filling the void. This
includes creditworthy, gainfully-employed and seemingly responsible
homeowners tapping home-equity lines. Such loans cost the banks
about 3.5 percent, which then lend the money to a home buyer
who doesn’t qualify for an insured loan at 12 percent.
This private uninsured mortgage market is a booming sub-prime
industry, similar to the one that brought down US financial
system in 2006-7.
only a matter of time before this shadow mortgage banking market
implodes, The impact of such a development will go beyond Canada.
As incremental credit evaporates, housing prices are likely
to fall and drag the Canadian dollar and Canada’s debt
rating with them. Might this result in a greater flight of capital
to US treasuries, forcing yields lower in the United States
and an incrementally stronger US dollar? Might this stronger
dollar further weaken crude prices, thereby hurting crude exporters
such as Venezuela, Iran and Russia while helping crude-importers
like India and China?
that 70 percent of household debt is associated with residential
real estate, there is a tight connection between mortgage debt
and real estate prices. Unlike the US real estate markets, which
corrected during the financial crisis, Canadian prices continue
an uninterrupted rise that began in the mid-late 1990s. Detached
single-family homes in Toronto now average more than C$1 million,
and Vancouver is now deemed the second least affordable city
in the world – thanks in large part to Chinese buyers
who are also facing a slower economy. The Economist magazine
recently noted that Canada's housing markets might be overvalued
by as much as 35 percent.
of the main reasons that Canada weathered the last financial
storm was due to a strong oil price and the corresponding jobs
created for Canadian workers. Collapsing oil prices have dramatically
altered the situation.
Canada report issued in March highlighted that Alberta was responsible
for almost 90 percent of all new jobs created in Canada in 2014.
That trend is now in reverse. According to construction industry
association BuildForce, Alberta is likely to see sustained job
losses for the next three years at a minimum. Further, because
Alberta drew workers from all over the country, any slowdown
will have national impact on unemployment. Not surprisingly,
Calgary and Edmonton real estate markets have been rapidly weakening.
Canadian leaders have very little in their control at this point.
The global credit and crude markets defy local control. Even
housing in Canada is more global than traditionally assumed
– just ask any Vancouver real estate agent. Dan Scarrow
of Macdonald Realty last month bluntly described the impact
of Chinese buyers: “Our analysis last year indicated that
roughly one-third of buyers in Vancouver had some connection
to mainland China.”
household debt, an overvalued housing market, lower oil prices
and a weak employment outlook have Canada teetering on the verge
of an economic bust. In fact, it may not take a home price drop
for chaos to ensue. Individual debt levels now need growth in
prices to keep the system working. Prices plateauing may be
sufficient for the house of cards to collapse.
China’s economic slowdown and the strong US dollar have
affected crude oil and other commodity prices negatively. Bank
of Canada Governor Stephen Poloz reduced interest rates this
January, clinging to a global trend of government stimulus spending,
in a quest to mitigate the negative economic impact of plummeting
oil prices. Lower interest rates fuel uninsured lending, but
higher rates would crush the consumer and make debt unmanageable.
prices, too, are largely out of Canada’s control. Vancouver
and Toronto are highly international cities, proving popular
with emerging market investors looking to park money. How much
of Chinese buying pressure is because of a desire to get money
out of China? One suspects that Chinese President Xi Jinping’s
anti-corruption effort is spurring more Chinese money into Canadian
housing. More than 20 percent of those in Canada are foreign
born. The insidious effect of rising housing prices with incessant
foreign-buying pressure is that it generates local fears of
being priced out of the market. Canadians scramble to participate,
and that drives additional credit.
lastly, the immediate catalyst of forthcoming economic pain
with lower crude oil prices is being driven by dynamics outside
of Canada. Whether it’s Saudi Arabia pumping more oil
in the face of overcapacity for political reasons or technological
developments in the United States allowing the shale boom to
continue, Canada has little control over the oil market. And
yet crude prices directly impact the federal budget. The best
Canada can do is to hope for higher oil prices.
Canadian consumer reminds one of the cartoon character Wile
E. Coyote who has run off the cliff, his feet still moving.
Suspended in air, he has yet to look down, and it’s only
a matter of time until gravity exerts its force.
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